Challenger Banks and Effect Of Rona on Risk ?

Passion Capital FS LP

How exposed some of the high profile challenger banks are to defaults and write offs on overdrafts in light of the rona situation.

We have had a look at challenger banks including Monzo and were a bit surprised when seeing some of the numbers in their last audited accounts as we were not aware that they have had so much capital out in overdrafts that long.

The more relevant extracts of the Financial Statements are below.

Looking at year end Feb 19 they had about 18m gross overdraft with a provision of 3m against it for accounts where the OD’s that have experienced significant increase in credit risk since initial recognition, but no objective evidence of impairment.

We would assume that the outstanding OD’s have grown significantly in the 12 months since Feb 19 and given the customer base who may have been impacted a lot by the Rona, there may be some quite large numbers in the Feb 20 accounts that might bring questions on the models and risk profiles.

The management of credit risk for provisions is detailed in the Pillar report.

We were very surprised by the apparent increase in OD’s as they seemed to have ramped up quite quick on this after going from the “mini” licence service powered by Wirecard to full and I imagine that the overdraft balances now are significantly higher with the growth.

Wirecard and Monzo named Best Prepaid Product of the Year

What possible risks do we see at Monzo Bank and other Challenger Banks?

  • If churn is high they may have some “ex customers” who have OD’s not paid off and if they are say 250 to 1k each what action will they take to recover when they probably also don’t want to be seen as a “ruthless” debt collector . Of course money is due when its due, but they may have a delicate PR consideration between debt collection and being a big stick collector
  • They may have had a significant number of EU nationals who were in UK for uni, language courses or seasonal labour etc and if they have OD’s and have gone back to EU , how or would they try to collect from someone who is now resident elsewhere in EU. Given the legacy product was a Wirecard prepaid card, we would expect sector to have been present in the portfolio of users.
  • If a decent amount of customer base is young/millennial etc they have a risk of a fair amount of furlough customers or gig workers who currently don’t have a gig and would look to possibly draw on whatever credit they have and worry about the repayment later.

With the larger banks it is hard to see this in the numbers as they have so many segments and its blended , but it stood out for us when we looked here and our gut feel is that Monzo have more credit risk than they budgeted and envisaged.

As capital raising gets harder if they do have a big dent here then some of the investors may start asking a lot more about business models and risk before stumping up fresh capital.

In addition the change in pricing of Overdrafts in the UK with effect from 1 April 2020 also possibly makes this a less attractive segment and product.

It is too early to see a default rate as last public accounts are Feb 19 and unlikely to see Feb 20 that need to be filed at the FCA/PRA by end of May until July or later at Companies House and perhaps later if numbers are not so positive. We have seen that Monzo have a track record of late filings at Companies House such as the Confirmation Statements a year late detailing insider share sales to Passion Capital FS LP and other investors .

Comparing to the Other Challenger Banks

Revolut fall out the mix as only a prepaid card promoter for Wirecard in their last accounts and there is no visibility on ODs until the next filing.

But, at Feb 19, Monzo has approved over 80m of OD’s to be drawn down of which about 18m had been taken. We would assume with their growth that may have double in approved amounts and the draw down may be way higher than 22% there was at Feb 19 which then had a 3m provision on 18m

Starling’s provisions are nowhere near as heavy which maybe be of course as less prudent on the provision calculation, or later in starting so less actual to put in a risk number based on what they have seen, or they may just have better quality debt. We did see Starling being one of the few to do diligence on Bounce Back Loan applicants on the Business side that suggests they are very aware of credit risk and have a robust up front review process and also of course a CEO with years of retail banking experience who has seen boom and bust times before.

Saying that Starling did have approved OD of 30m , drawn down 9m which at 30% or so is a lot higher draw down than Monzo.

Our gut feel is that these guys are having a lot of conversations about provisions and cash and balance sheet exposures given the change in circumstances for potentially a big % of their OD holders and making a dent in reg capital and this may be a bigger issue for some than a loss in interchange net fees for the next few months.

Of course it is not so useful  as they only report once a year and then usually 9 months after the year end and we see accounts 12 months after the year end so its very out of date in a fast moving sector.

Saying that, looking at numbers and the customer base then in our opinion we think there is a risk that bad debt exposure has increased and the business models relating to OD’s may need some tweaking.

It will be interesting to see 2020 Financial statements of all the Challengers as by then they have all had at least one year post prepaid cards and will be able to see metrics relating to their core business models and not being a prepaid card promoter for Wirecard.

The Board at Monzo Bank include some big hitters in the sector including Eileen Burbidge of Passion Capital who were sat on paper gains of 443m GBP based on the most recent Confirmation Statement filed and the Round F share price, Garry Hoffman, a financial services veteran and Chairman of the Premier League

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